Executive pay: does it need to be transparent?

10 November 2015 -

How best to disclose executive pay has long been a hot topic, but a recent report from PwC reveals how the most transparent companies are often the best-aligned with business performance

Jermaine Haughton

The dilemma of how to best compensate company executives has been a head-scratcher for many shareholders and boards, with the added pressure of the Government and regulators in recent years, but a new report from PwC has found that the UK’s largest companies are increasingly aligning executive pay to business performance.

Entitled Sunlight is the best disinfectant, the study found that the executive bonus payouts of FTSE 100 company chiefs have significantly increased since 2012, as business performances has similarly improved during the same period.

Tracking the link between bonus outcomes and performance, where 0% would suggest no correlation between the two categories and 100% would represent perfect correlation, the PwC analysis found the link grew from 6% in 2011 to 19% in 2012.

The correlation between bonus payouts and company performance became particularly strong in 2013 and 2014, with a 25% and 33% correlation respectively, when the Government’s proposals for better pay disclosure came into force. The requirements are intended to provide investors with more defined criteria as to how director payouts are calculated. These regulations encouraged more firms to publicise their senior management pay levels, business targets and outcomes, and included a binding shareholder vote on executive pay policy.

Fiona Camenzuli, pay, performance and risk partner at PwC, said: “Executive pay has remained broadly static in real terms and has become harder to earn since the financial crisis, but trust in the system remains low.

“Distrust in executive pay is driven by the belief in some quarters that bonuses don't reflect performance. Our research suggests that the discipline of better disclosure of how bonus targets are set and met is significantly improving the link between pay and performance.”

Companies who make the most transparent salary disclosures have an even greater link between executive payouts and business performance.

Based on remuneration reports published for the 2014 financial year, the correlation value for the companies making the best disclosure of threshold, target and maximum performance requirements is more than twice that of the other companies.

Nearly a quarter (24%) disclosed the level of performance required to generate an ‘on-target’ bonus but not the full range of performance targets, while 12% made some indication of where performance had been against the targets.

However, some 28% made very limited disclosure or opted out on the basis of commercial sensitivity, the report said, by using a clause in the legislation which allows firms to strictly limit the way they reveal targets set by the remuneration committee if they feel it would give away commercially sensitive information.

Camenzuli added: “Pay has become more strongly linked to performance since companies have been required to provide fuller disclosure. The link between pay and performance is twice as high in the FTSE 100 companies that provide full target disclosure than in those that don't.

“It is right that investors should know how executive pay tallies to company performance and it seems inevitable that investors will eventually push all companies to adopt the most transparent requirements. Disclosure is often accused of fuelling increases in executive pay, but in this case greater disclosure is leading to a better link between pay and performance.”